Introduction to dividend

When investors think of passive income, one term that frequently comes up is Why Do Companies Pay Dividends?

Rewarding Investors: Dividends are a way for companies to share their success with shareholders, rewarding them for their loyalty and trust.
Sign of Stability: Dividend-paying companies are often viewed as financially stable. If a company can afford to pay dividends regularly, it indicates consistent profitability.
Attracting Long-Term Investors: Offering regular dividends can entice long-term investors who seek passive income, helping a company maintain a strong shareholder base.

How Do Dividends Work?

Dividends are usually expressed in two forms: cash dividends or stock dividends.

Cash Dividends: The most common type, cash dividends are payments made directly in cash to the investor’s brokerage account.
Stock Dividends: Instead of paying cash, companies may issue additional shares to shareholders.

In some cases, companies may choose to pay dividends in the form of assets instead of cash or stock. This can include distributing shares of another company. For instance, a company that holds a stake in another business might choose to distribute those shares to its own shareholders. This often happens during spin-offs or when a company wants to divest its investment holdings. While less common, this form of dividend allows shareholders to receive shares in another company, which they can hold or sell as they see fit.

Key Dates to Know:

Declaration Date: The day the company announces it will pay a dividend.
Ex-Dividend Date: The cut-off date to be eligible for the dividend. If you purchase shares on or after this date, you won’t receive the dividend.
Record Date: The day the company reviews its list of shareholders to determine who will receive the dividend.
Payment Date: The day dividends are paid out.

Dividend Yield: How Much Are You Earning?

One of the primary metrics investors use to evaluate dividend stocks is the dividend yield. This is calculated by dividing the annual dividend per share by the stock’s current price.

For example, if a company pays a RM0.05 annual dividend and its stock is trading at RM1.00, the dividend yield is:

Dividend Yield = (RM0.05 ÷ RM1.00) × 100 = 5%

Dividend yield gives investors a sense of how much income they can expect relative to the price of the stock. It’s a crucial metric for income-focused investors, though it’s important to remember that yield alone isn’t everything. A company with a high yield but declining business prospects might not be sustainable in the long run.

The Benefits of Dividend Investing

Passive Income: One of the primary attractions of dividends is the steady stream of passive income they provide. This can be especially appealing to retirees or anyone looking to supplement their income.
Compounding Power: If you reinvest dividends back into buying more shares, over time, you can harness the power of compound growth. Many brokers even offer automatic dividend reinvestment plans (DRIPs).
Lower Risk: Dividend-paying stocks, particularly from well-established companies, can be less volatile than growth stocks, making them a lower-risk option for investors seeking stability.

Types of Dividend Stocks

Blue-Chip Companies: Large, established companies with a long track record of stable earnings and regular dividend payments. Examples include companies like MAYBANK and NESTLE.
High-Yield Stocks: Companies, often in sectors like utilities and real estate investment trusts (REITs), that offer higher-than-average dividend yields. However, higher yields can sometimes signal higher risk, so it’s essential to assess the company’s overall financial health.

Risks to Consider

Dividend Cuts: Companies aren’t obligated to pay dividends, and in tough financial times, they may reduce or eliminate dividends altogether.
Market Volatility: While dividend stocks tend to be less volatile, they’re not immune to market downturns.

Taxation of Dividends in Malaysia: Single-Tier System

Malaysia operates under a single-tier tax system for dividends. This means that the company paying the dividend has already been taxed on its profits at the corporate level, and the dividends distributed to shareholders are tax-exempt in the hands of investors.

As a result, investors do not need to pay additional taxes on dividends received from Malaysian companies. This is a significant benefit for local investors as it allows them to enjoy the full dividend without further deductions.

However, for international investors, such as those investing in US stocks, it’s essential to consider withholding tax on dividends.

US Dividend Tax: When you receive dividends from US companies, the US government imposes a 30% withholding tax on the dividends paid to non-US investors. However, under the US-Malaysia tax treaty, this withholding tax can be reduced to 15% for Malaysian residents.
- For example, if you earn $100 in dividends from a US company, only $85 will be credited to your account after the 15% tax deduction.

This tax is automatically withheld by your broker, so you don’t have to file additional paperwork for it. However, it’s important to consider this tax when planning your international dividend investments, as it reduces the overall return from your dividend income.

Conclusion: Building a Dividend Portfolio

Investing in dividend stocks is an excellent strategy for those seeking passive income, long-term stability, or a mix of both. The key to success in dividend investing is to research companies thoroughly and focus on those with strong balance sheets, sustainable earnings, and a history of paying regular dividends.

If you’re looking to start a dividend-focused portfolio, consider balancing blue-chip stocks like GENM and TENAGA with companies that have a strong history of growing their dividends. Always evaluate the dividend yield, payout ratio, and the company’s overall financial health before making a decision.